Benefits and limitations of borrowing through your SMSF

Please note that the information we provide here is not advice but general information only. SMSFs are complex and as a matter of practice require minimum investable amounts. You need to seek professional advice before considering one.

At one time, an SMSF could not borrow funds to invest in assets. The rules were relaxed in 2007 and have been refined in recent years. It is now possible for an SMSF to borrow to acquire assets – providing certain rules and restrictions are adhered to.

Some good reasons for SMSF borrowing
SMSF borrowing can allow the fund to invest in assets it may otherwise not have sufficient cash to purchase. By borrowing, the fund can diversify its investments and improve its income and growth. There is also the scope for tax deductibility on interest payments, as well as franking credits within the fund.

The types of investments that the fund can borrow for are fairly broad, and include residential or commercial property, land, shares, machinery, factories, and even farms. The restrictions which apply are stringent but may in some cases be subject to interpretation.

The lender does not necessarily have to be a bank or finance company, but could be a family member, business partner, associate or even a fund member.

Repayments need to be made from superannuation contributions and / or from investment earnings.

Some challenges with borrowing via an SMSF
There are some rather complex rules to follow when borrowing within an SMSF.

SMSF borrowing for assets can only be done under an LRBA – Limited Recourse Borrowing Arrangement.

Under an LRBA: Only one asset can be acquired or a collection of identical assets (such as a parcel of identical shares for example), under any one borrowing arrangement. In each case the single asset becomes security for the loan, with the asset being held in a holding trust until the loan is repaid.

Assets can be repaired or maintained but cannot be improved upon or replaced with borrowed funds (except under exceptional circumstances).

This means that under borrowing rules, shares cannot be actively traded or sold, nor is there scope for property development.

It is possible for assets to undergo repairs or maintenance, although the difference between ‘repairs’ and ‘improvements’ is not always clear cut. As an example, the renovation of an older home may be allowed, as would repairs or maintenance of a building to prevent deterioration. However, adding an extension would generally not be permitted – at least not using borrowed funds. It may be possible to make improvements to the asset using non-borrowed funds.

SMSF borrowing may not be entirely straightforward, so it’s important to seek professional advice regarding the rules, and also with regard to any associated taxation implications.

The ATO provides guidance on limited recourse borrowing arrangements on its website.

Life Insurance
Life insurance that is designed to comply with the regulatory requirements for SMSFs can be particularly important, as it could provide funds for the outstanding loan repayment in the event of an untimely death or total and permanent disability. It’s also a good idea to look for a life insurance product which offers the flexibility of being able to move it outside the fund if circumstances change.

NobleOak offers Premium Life Direct, with Life, TPD and Disability Income cover (also known as Income Protection) cover that can be included within an SMSF.

There are a number of benefits to holding life insurance in an SMSF, including increased personal cash flow and the effective tax deductibility of the insurance premiums to the Trustee of the superfund. There are also downsides and you should seek expert advice about the impact upon superannuation concessional caps and the effect of premiums on investment returns.

Because your insurance premiums are paid from your SMSF contributions, you no longer have to come up with the additional money yourself. This can be useful for anyone who needs to maintain their after-tax cash flow, but still understands the importance of personal risk insurance.

Life Insurance and Tax
Premiums for Life Insurance and TPD Insurance are generally not tax deductible when held directly (outside of your SMSF). However, when they are paid for using the money in your SMSF, they are effectively tax deductible to the Trustee of the super fund against other taxable income of the super fund (such as tax deductible contributions made to the super fund). If they are paid from your concessional contribution, then they are paid out of gross income (but payment this way reduces amounts you can contribute to superannuation). This can be highly advantageous.